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Companies Prefer Performance-Based Compensation

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One main consequence is the decline of stock options and the rise of restricted stock units, which does not dilute a company’s stock as much as options.

With stock options being categorized as non-performance-based and the continuing negative press stemming from the dot-com boom and bust, the WorldCom/Enron scandal and the 2008 crisis, executive compensation consultancy Meridian notes that companies have reduced their emphasis on stock options in favor of more performance-based shares.

In fact, the share of S&P 1500 companies that issued stock options fell from 67.5% in 2010 to 57.4% in 2014, according to executive compensation firm Equilar.

Several factors explain the decline of stock options. Activist shareholders have managed to push back successfully on stock options plans, which, they maintain, do not represent a long-term incentive for executive performance. Also, revised accounting standards have forced companies to claim an accounting expense for the value of stock options granted.

A stock option gives the buyer the right to buy or sell shares at a predetermined price within a fixed period of time. But they have become complex to manage. Moreover, stock valuations in recent years have made many stock option plans uneconomical since the option exercise price is often significantly higher than the stock price.

This trend applies to directors’ compensation as well. “Grants of restricted stock are more direct as a form of deferred compensation, and keep directors focused on longer-term profitability for the company,” says Nancy May, president and CEO of corporate governance advisory firm BoardBench. Yet, board members may act differently, once the stocks are vested. “There is a temptation to manipulate share prices through various actions (company share buybacks, delays in research and development and other expenses) to improve or preserve the original value of those granted shares around the anticipated time of sale,” says May.